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I am working on the capital gains taxes that the United States IRS demands (Form 8949 and Schedule D). Choosing a good algorithm for picking a cost basis for a sale seems to not be easy in the following situation:

  • The items you are buying and selling are indistinguishable.
  • You can buy arbitrary quantities of them for an arbitrary price.
  • You care about rounding errors.
  • You care about making future tax returns consistent with past ones.
  • No one provides a Form 1099-B to you.

For example, suppose I bought 6 items for $0.17. (I am picking small numbers in this example to make it easy to see my point.) Then I sold each item individually, for various prices. I will need to report 6 cost bases to the IRS, and I think they need to add up to $0.17. The true cost basis of each item is 0.17/6, but I can't put that on a tax form because its decimal representation is infinitely long (0.02833333333...). Let's assume I want cost bases that do not have fractional pennies. Then a reasonable algorithm for this situation might assign the items to have these cost bases: 0.03, 0.03, 0.03, 0.03, 0.03, 0.02.

Another important thing to note is that I will be running this algorithm over multiple tax years. So I don't want a sale in 2016 to affect the cost basis of a sale I already reported on my 2015 tax return.

What is a good algorithm/method to pick each cost basis in situations like this?

  • Given that US taxes let you round off to the dollar, I suspect you're overthinking this... I'm mostly using first in first out accounting since I have those records and that's how my funds like to report results. – keshlam Apr 5 '15 at 19:27
  • The IRS doesn't care about rounding errors. – Pete Becker Feb 8 '17 at 13:26
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I will need to report 6 cost bases to the IRS, and I think they need to add up to $0.17

Not at all. If you're rounding, the IRS requires data rounded to the closest full dollar. In this case, the cost basis will be $0 for all items.

What is a good algorithm/method to pick each cost basis in situations like this?

You don't need any algorithms. All you need is to be consistent. You can choose to report cents, and then you must report cents everywhere on your return. You can choose not to report cents - similarly, must be consistent everywhere on your return. You do not have to be consistent across returns, you can report cents on your 2014 return, and not report them on your 2015 return, up to you.

Rounding rules are standard math rounding rules, you round to the closest full value (either cents or dollars, as you chose for your return).

Rounding errors within $1 are perfectly fine. I.e.: your actual cost basis is $0.17, but you rounded down to $0.00 - that's fine. Similarly, $0.028333... is rounded to $0.03 if you report cents, even if the sum is 0.18 and not the actually paid 0.17. That is fine.

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